Chapter Two: Working Capital Management
Defining Working Capital
The term working capital refers to the amount of capital which is
readily available to an organisation. That is, working capital is the difference between resources in cash or readily convertible
into cash (Current Assets) and organisational commitments for which cash will soon be required (Current Liabilities).
Current Assets are resources which are in cash or will soon be converted
into cash in "the ordinary course of business".
Current Liabilities are commitments which will soon require cash
settlement in "the ordinary course of business".
WORKING CAPITAL = CURRENT ASSETS - CURRENT LIABILITIES
In a department's Statement of Financial Position, these components
of working capital are reported under the following headings:
The Importance of Good Working Capital Management
Working capital constitutes part of the Crown's investment in a department.
Associated with this is an opportunity cost to the Crown. (Money invested in one area may "cost" opportunities for investment
in other areas.) If a department is operating with more working capital than is necessary, this over-investment represents
an unnecessary cost to the Crown.
From a department's point of view, excess working capital means operating
inefficiencies. In addition, unnecessary working capital increases the amount of the capital charge which departments are
required to meet from 1 July 1991.
Approaches to Working Capital Management
The objective of working capital management is to maintain the optimum
balance of each of the working capital components. This includes making sure that funds are held as cash in bank deposits
for as long as and in the largest amounts possible, thereby maximising the interest earned. However, such cash may more appropriately
be "invested" in other assets or in reducing other liabilities.
Working capital management takes place on two levels:
Ratio analysis can be used to monitor overall trends in working
capital and to identify areas requiring closer management (see Chapter Three).
The individual components of working capital can be effectively
managed by using various techniques and strategies (see Chapter Four).
When considering these techniques and strategies, departments need
to recognise that each department has a unique mix of working capital components. The emphasis that needs to be placed on
each component varies according to department. For example, some departments have significant inventory levels; others have
little if any inventory.
Furthermore, working capital management is not an end in itself.
It is an integral part of the department's overall management. The needs of efficient working capital management must be considered
in relation to other aspects of the department's financial and non-financial performance.